Pethokoukis, Economics, U.S. Economy

Stunning new study dismantles Obama’s “1% vs. 99%” inequality argument

Image Credit: REUTERS

Image Credit: REUTERS

“This growing inequality,” President Obama said during his recent Knox College speech, “is not just morally wrong, it’s bad economics.”

A strong statement — but one not supported by data, suggests a blockbuster new study by economists Steven Kaplan (University of Chicago) and Joshua Rauh (Stanford University). They examine two possible explanations for the rise in top-end inequality in their paper “It’s the Market: The Broad-Based Rise in the Return to Top Talent”:

1. The Superstar Syndrome. Technology and globalization has enabled highly talented and educated individuals to manage or perform on a larger scale, “applying their talent to greater pools of resources and reaching larger numbers of people, thus becoming more productive and higher paid.”

2. The “Greed is Good” Syndrome. Then again, maybe compliant corporate boards overpay CEOs, social norms against “exorbitant pay levels have broken down, or tax policy affects the distribution of surpluses between employers and employees.”

In their paper, Kaplan and Rauh conclude “it’s the market” rather than some class-wafaresque malfeasance at play. Here’s why:

1.The increase in pay at the highest income levels is broad-based: Public company executives, private company executives, hedge fund and private equity investors, Wall Street bankers, lawyers, and pro athletes have all experienced big jumps in pay over the past few decades. The researchers:

If the reason for growth of incomes at the very top is, say, managerial power in publicly owned companies, then one would expect the increases in income at the top levels to be much larger for that group. But the breadth of the occupations that have seen a rise in top income levels is much more consistent with the argument that the increase in “superstar” pay (or pay at the top) has been driven by the growth of information and communications technology, and the ways this technology allows individuals with particular skills that are in high demand to expand the scale of their performance.

2. Typical measures of high-end income inequality are incomplete. Inequality alarmists typically point to data from Thomas Piketty and Emmanel Saez which show the share of taxable income accruing to the top 1% up markedly since 1980 and at levels not seen since the Roaring ’20s. Yet once you add back transfer and taxes, as the Congressional Budget Office does in its analysis, you find that government policy — including the tax code — has already been restraining the rise inequality. Kaplan and Rauh: “In the most recent data from 2009, the aftertax, after-transfer income share of the top 1 percent was around the same level as in 1987–1988, 1996, and 2001.”

Credit: Steven Kaplan and Joshua Rauh

Credit: Steven Kaplan and Joshua Rauh

3. The superrich are getting that way through effort and education — particularly in industries where tech and globalization play a big role — rather than through inheritance:

Credit: Steven Kaplan and Joshua Rauh

Credit: Steven Kaplan and Joshua Rauh

The researchers also find “a trend in the Forbes 400 list away from people who grew up wealthy and inherited businesses towards those who grew up with more modest wealth in the family and started their own businesses.”

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The researchers conclude:

Our evidence is not obviously consistent with those who suggest that the increase in pay at the top is driven by a recent removal of social norms regarding pay inequality. While top executive pay has increased, so has the pay of other groups, who are and were less subject to disclosure and, arguably, less subject to social norms. This is particularly true of private company executives and hedge fund and private equity investors.

Overall, we believe that our evidence remains more favorable toward the theories that root inequality in economic factors, especially skill-biased technological change, greater scale, and their interaction. Skill-biased technological change predicts that inequality will increase if technological progress raises the productivity of skilled workers relative to unskilled workers and/or raises the price of goods made by skilled workers relative to those made by unskilled workers. For example, computers and advances in information technology may complement skilled labor and substitute for unskilled labor. This seems likely to provide part, or even much, of the explanation for the increase in pay of professional athletes (technology increases their marginal product by allowing them to reach more consumers), Wall Street investors (technology allows them to acquire information and trade large amounts more easily) and executives, as well as the surge in technology entrepreneurs in the Forbes 400. Globalization may have contributed to greater scale, but globalization cannot drive the increase in inequality at the top levels given the breadth of the phenomenon across the occupations we study.

Also keep in mind that Obama is almost certainly wrong in his Knox College claim that the “link between higher productivity and people’s wages and salaries was severed – the income of the top 1 percent nearly quadrupled from 1979 to 2007, while the typical family’s barely budged.” As the Washington Post points out:

The CBO finds that, before taking taxes and transfers (like Social Security or the Earned Income Tax Credit) into account, real median household incomes grew 19.9 percent between 1979 and 2007; after taking transfers but not taxes into account, they grew 30 percent; and after taxes, they grew 38.2 percent … real median household incomes in America are growing, and it’s inaccurate of Obama to suggest otherwise.

So high-end inequality is likely a) being mainly driven by market forces and b) not having an obvious impact on the economic well being of the American middle-class. And keep in mind inequality is only a 1% vs. 99% thing. As Northwestern University economist Robert Gordon has pointed out, there’s been “no increase of inequality after 1993 in the bottom 99 percent of the population, and the remaining increase of inequality can be entirely explained by the behavior of incomes in the top 1 percent.”

In other words, the core thesis of Obamanomics — the rich have immorally gaffed all the income gains of the past 30 years and its time to redistribute — doesn’t seem to hold up. Rather than attacking the 1% or 0.1% or 0.01%, Washington should be focusing on boosting growth and economic mobility through education reform and improving innovation-driven productivity.

22 thoughts on “Stunning new study dismantles Obama’s “1% vs. 99%” inequality argument

  1. Excellent and important article, but I would quibble with one point:

    “Yet once you add back transfer and taxes, as the Congressional Budget Office does in its analysis, you find that government policy — including the tax code — has already been restraining the rise inequality.”

    That is not the only difference between Pickety& Saez and CBO. The CBO also makes a number of adjustments (household size, broader definitions of income, health care benefits etc.). Even before taking taxes into account, Pickety& Saez find that the top one percent earned 18.1% of income in 2009 while the CBO estimates 13.4%.

    http://www.cbo.gov/publication/43373
    http://elsa.berkeley.edu/~saez/TabFig2011prel.xls

    Inequality has been rising as Picket and Saez first demonstrated, but Pickety& Saez rely on a questionable methodology to exaggerate the magnitude.

    This is most important when estimating the income growth of the middle class. The CBO adjust for household size, employer provided health care etc. and finds middle class income rising by 35-50% since 1979, while Pickety and Saez data shows almost zero growth.

  2. the banksters and wall street gamblers are getting so rich ($100 million salaries) by gaming the system and NOT through education (unless you consider being taught how to game the system is “education”)

  3. To quote from another context, WHAT DIFFERENCE DOES IT MAKE?

    If you’re one of those who think that taking down (or from) the successful will benefit you in some way, then why would you care how they became successful?

    Obama isn’t trying to punish the sinful; he’s exploiting one of the oldest motivations in history:

    They’ve got it. I want it.

  4. So the argument being made to justify the unprecedented wealth gap we now have in the US is that the top 1% are 500 times more educated and/or work 500 times harder than everyone else? And this at a time when the population as a whole is the most educated it has ever been and working longer hours with fewer vacations than it ever has.

    You truly have to be uneducated to believe the premises made by the 1% in their spin of things. Yea, right, survival of the fittest! Hooray for social Darwinism!

    • Sadly Asies this is exactly true and easy to see. The majority of all the students in every city public school are functionally illiterate. Moreover even for kids who go to college the vast majority learn very little and don’t have the required intelligence to learn true college level work. Once you get past the top 50 colleges all the rest are mostly non-selective with low graduation rates and very little studying. Meanwhile the workload at the elite colleges has increased and the top 1% which is really the top 3-5% almost exclusively attend these top colleges because they are the students with IQ’s over 120. It is IQ that has created the income inequality because in today’s world there is no substitute for creative intelligence in boosting overall productivity.

    • “So the argument being made to justify the unprecedented wealth gap we now have in the US is that the top 1% are 500 times more educated and/or work 500 times harder than everyone else?”

      You’re trying to miss the point, aren’t you?

      First of all, “education” is relative. There is, after all, an enormous qualitative difference between a computer science degree and liberal arts mush. The push for everyone to get 4 year degrees of questionable value has resulted in a huge portion of the population with tens of thousands in student debt and a dilution of the relative value of being college educated. More supply of college grads, and a simultaneous drop in the quality of information they’ve acquired. This is hardly a guarantee that this “education” will necessarily raise incomes.

      Two, it isn’t generically “education” and the number of hours work the study’s authors are citing as the rise in equality, it’s the scarcity and value of their skill.

    • I’d like to know what you base these ridiculous statements on. Just because we have kids with BS degrees waiting tables DOES NOT MAKE THEM EDUCATED. Spending $50,000 to get a degree in “women’s studies” or some other dumb degree DOES NOT MAKE YOU EDUCATED. I would, in fact, argue (and successfully) that you are clearly UNEDUCATED if you are too stupid to realize that some things have value and SOME DO NOT. I can mine dirt all day long, working my butt off………..BUT IT’S NOT WORTH MUCH. Welcome to the real world.

  5. One sarcastically says, “Hooray for social Darwinism,” a philosophy of the political Left, while another comments about “banksters,” without noting that the Fed as a government instrument is made up of such men while the Fed is essentially cash poor and undercapitalized. Yet another cites “middle class income rising” in the face of a record drop in labor participation rates. Let us not forget the massive national debt, which must be re-figured by adding in municipal, county, state and school systems’ public debt. The nation is not unequal. It is deeply mired in the corruption of paying for today’s “noble” causes on the back’s of tomorrow’s taxpayers. The element missing in all the politics of today is simple freedom. The concept requires a preposition, and that preposition is “from.” Freedom from debt is freedom from the kind of government the nation has grown to tolerate. It will come in the same manner that the implosion of the USSR surprised many, notably the federal government’s brightest and best who reported that failing economy as bigger and stronger than it proved to be. What is being seen in municipal bankruptcies is a microcosm of Obama’s inequality argument, for human and financial capital is fungible and moves in flight from the “1% versus 99%” sorts of redistribution arguments. In reality, one only need look at many in Obama’s circle, wealthy far beyond most of Americans and most certainly in the upper two or three percentile of all Americans. These are the manipulative people using redistribution politics, for only one purpose. To acquire more for themselves by keeping “inequality” arguments alive and loud. One considers Robert Reich’s recent piece in HuffPo about such inequality, all the while his income from public funds places him within the 95th percentile. Similarly, Rattner and Gore and the Clintons all are in that top bracket, courtesy of crony capitalism, a lingo which is anything but capitalism. Most of Congress is wealthy, as are most public university presidents, as examples of the “superstar” game reliant wholly on public funds and public debt to keep such funds flowing. The “1%” argument has always been spurious and envy-based, as one learns demagogues like Moore are in this economic class through disparaging it. Without government picking winners and losers as has been the politics of the last decades, true prosperity would b growing. With government picking “winners” one gets Solyndra and Detroit — examples of the temporary survival of the unfit — and the NSA’s enormous costs — one among many levels of gathering government — heaped onto the rising tide of public insolvency. One needs no study to dismantle anything; one only needs greater freedom from government and greater clarity from people who would trot out “social Darwinism” and lingo like “the 1%” and “banksters” in place of factual information. The facts are plain: freedom diminishes as government demands it tribute — a re-dis-tribute scheme in which those who produce are requiring to give up as tribute the results of productivity to those who do not produce. The story is centuries old, while its modern dress obscures this truth. Our “betters” seek their rents, once by the divine right of kings and now be the wisdom of social welfare government. In all cases, coercion is in force.

    • This is the most “pedantic” bunch of garbage I have EVER read. I would recommend that you learn to write…not to impress, but to actually make sense. You take ten different sides hoping to appear to know what you are saying, when in reality, you do not. It would be helpful if you were to get all the facts, and then learn how to write for the purpose of “communicating” which is what solves problems. The Earth belongs to EVERY human being, not just the sociopaths who are hoarding its supplies at the expense of the less fortunate.

  6. In Table 2 the “share” is given in fractions, not percentages. So 1.000 would represent the entire Forbes 400. According to the authors Finance has grown by about 16% (.160) since 1982. According to Ferguson in “Inside Job” and “Predator Nation” that’s less than half of what really happened. It’s precisely in this area that one would look for criminal activity, for rewards unjustified by increased productivity. So I would say that this study is crap and the AEI should by renamed the American Criminal Institute for publishing it.

  7. What both sides gloss over is that Obama is partly responsible for the current and growing wealth inequality. Natures mechanism for redressing wealth inequality is bank failure and the massive deflation that results from it. When banks fail, the assets of the richest are wiped out more, because they have bigger accounts and no deposit insurance for most of their money. In our bailout driven economy, the assets of the richest have been artificially preserved. QE also helps preserve and expand wealth inequality be squeezing the middle class from both ends. Ultimately, a system reset is necessary, and it eventually will happen. The longer one waits, the more Epic it will be.

  8. A class that is reared in an environment, where nothing is little Johnnie’s fault, and his work ethic is quashed as something to be disdained. Undesirable. Creates a class of people perfectly happy in their laziness. Perfectly happy to play the system for minimal gain. Just fine with sitting on their asses mastering a TV remote control. Their will always be a growing divide when one part of society is content being low info, and lazy.

  9. The ONLY sub-set of the 1% that Barry needs to clip are his own cronies.

    The bizarre move to hyper-concentration is highly correlated with ACCESS TO LEVERAGE — and closeness to the Fedsury teat.

    That’s where all of the recent super fortunes have been made. They’re sort of a Daddy Warbucks — without the war.

    Big Media, Big Medicine, Big Pharma, Wall Street, Silicon Valley, Mega Banks and hangers on to such crowds intended to do good — but did very well, instead.

    Often they are the first to touch the newly minted monies spewed forth by the Fedsury.

    Thus, we have Mugabe on the Potomac.

    In a fiat financial system debasement of the currency equals a WEALTH TAX. It is untrue that the government is borrowing money. It’s PRINTING IT.

    Consequently, spending = taxation.

    They are mathematical identities in a fiat regime.

    It’s not as if todays ‘borrowed dollars’ will have any relation to their redeemed value.

    The Fedsury is going to have to ‘buy the duration’ so as to thwart a total collapse in the banking sector. Twist doesn’t go far enough.

  10. If Mr. Obama was more concerned about why upward mobility among the lower 99% is stuck and how to fix that then we would have a useful president.

    It’s not a fixed sized pie. It can grow. Work on that instead of punishing the successful and everyone will have a better chance at the American dream.

  11. This is an interesting article with good discussion. If you look back through history, you will always find the “Haves” and the “Have Nots”. Why? Several reasons; first, if you divided all the world’s wealth equally today, it would only be a short time until it was way out of balance again, because some people simply can’t make good decisions when it comes to money. They waste it. We have seen lottery winners go broke in a short time. Second, there will always be contributors to society, there will be those who work at a steady pace, and there will be slackers. These groups will eventually become the top 1%, the middle, and the poor working classes. Third, then you have folks who thirst for knowledge and make it a life long goal to learn everything they can, they become the highly educated. You have those who go into fields that require mediocre effort and those who just want to earn an easy degree with little to no effort. They will eventually “reap what they sowed.” I for one, would just like society to quit making excuses and accept that we generally get out of life what we put into it based on choices ( free will) that we have made. Now, there are extraordinary events that may occur ( i.e. illness, loss of job, loss of family members), which knock us off balance at times. It may even result in kicking us in a lower class, but with all the social programs in this country, we can get back to where we were if we really want to. It all comes down to personal choice, and the amount of effort you’re willing to give (see Vroom’s Expectancy Theory of Motivation). Bottom line, quit blaming the system, the big bad corporations, the college you went to, the school system, Mom and Dad, society and so forth and just make better choices!

    • You neglected to mention a most important category; powerful thieves. For most of human history they were called aristocrats. Today they are called financiers in the English speaking world.

  12. extortion and exploitation

    Buffet, Facebook, Amazon did none of that,

    while others did. meaning the flawed study, can suggest anything, but can prove nothing

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